Summary: As the recent wave of operator consolidations looks set to continue, Scott Antel discusses the implications of this trend for owners, and how it may not necessarily be good news.
The operator’s “party line” when it comes to the advantages of consolidation is that it is all about “benefits to owners”: scale economies, reduced distribution costs and greater power to fight OTA margin erosion.
Whilst there may be some truth to these merger “benefits” to hotel owners, there is indeed more to the story; a part of which threatens to shift the commercial balance of power more in favour of the large operators, something beyond the obvious power shift resulting from reduced owner/consumer choice in many markets. Following a chain acquisition, some operators may attempt to convert the acquired group’s hotel property management systems (involving very substantial IT systems conversions) to systems used by the surviving group and attempt to pass this conversion off as a mandatory Brand Standard change. This is packaged as a “systems upgrade” and combined with various added shared services initiatives which are sold as driving down transaction costs. These include many essential functions, traditionally the reserve of the hotel (e.g., purchasing, accounts payable, accounting and sales).
No doubt there are some benefits of systems harmonisation and clustering; but this quite substantial cost to the owners of acquired group hotels, is not justified by systems or technology upgrades, so much as it is a merger integration cost which ought to rightly be borne by the acquiring company. The acquired group owners have no say in approving the merger and are already required under their original HMA contract to install the acquired operator’s standard property systems. Now they are asked to incur this systems cost again without being able to amortise their original investment.
Disregarding whether it is commercially acceptable or contractually legal to push one’s merger costs on to your acquired contract client in the name of Brand Standard changes; the larger long term issue for brand hotel owners is the operator’s seizure of control over traditional key in house activities performed at the hotel, using owner’s personnel and taking them outside to be performed by unknown parties. Whilst outsourcing or shared services is not uncommon and can often deliver substantial savings to businesses, the operator in this instance is not just outsourcing to one of its affiliates; in many instances it is subcontracting these primary functions it contracted to perform under the HMA to 3rd parties. This yet further reduces the “hands on” management of the large operators at their brand hotels (arguably already light – how can you manage a hotel when the only “manager” personnel are the General Manager and Finance Director… and the owner has to employ them!). It also raises a number of commercial, legal and cultural issues, including:
- The owner loses all control over the key hotel payments and accounting functions, working capital control and ownership of the systems, personnel and the capacity to administer and monitor these functions in the operator’s absence. Effectively, the operator is structurally preventing their redundancy.
- It creates reduced transparency on indirect procurement aspects, including volume discounts/rebates offered to the operator from centralised procurement, etc. And it disregards any legitimate local vendors, preferred by the owner, which in many smaller markets, can provide a better level of service for less than the operator’s centralised vendor.
- The operator effectively selects the shared service bank (possibly offshore) to maintain and operate the Hotel Operating Account. This has numerous implications: a) it potentially violates the owner’s HMA right to select the Operating Account bank; b) placing this activity offshore may have local currency control, tax and localised accounting requirement implications; and c) it can impact debt facility/loan condition implications to owner groups who have bank facility arrangements in place with a preferred bank for their larger business interests. These facilities usually want to be able to capture all cash inflows into a central Group account held by that bank. This would entirely disrupt this lending structure.
- Frequently the HMA and/or local legal requirements require that the Hotel books and records be maintained on site at the Hotel. This structure can take them outside the Hotel without owner’s consent and make it much more difficult for owner or their asset manager to oversee.
- Such standardised shared service systems are typically initially rolled out in more developed markets such as North America. But developing markets like Russia/CIS, the Middle-East or SE Asia are “not Kansas” and what may work in a large, mature and homogeneous market may be completely unacceptable in developing markets from a cultural and legal perspective.
- In many jurisdictions, the accounting and tax functions must be performed and signed off by designated in house personnel, with mistakes or violations potentially resulting in criminal liability to the owner and/or the responsible personnel. An exculpatory excuse that “the outsourcing company got it wrong” is not going to be a defence to an unwitting owner.
- As more and more systems become automated or placed on Cloud solutions, this “offshoring” of the business and the loss of control by owners over the processes and systems for operating and monitoring their hotel means that the owner becomes ever more dependent on the operator to run its business and less able to monitor what they do or to step in should things go wrong. And this is being done without the HMA being modified to place more accountability on the operator commensurate with their greater control over hotel’s operations.
This seems another example of the big operators’ race to scale and increasing “McDonaldization” of an industry that remains in its essence quite personal and local in nature. One size does not fit all in hotel operations, particularly across borders. I recall being asked to implement a cluster scheme for a large group in Russia some years ago. From a business consultant’s mind-set it made absolute sense. But when you got to the local cultural aspects, there was no way a local owner with a lifelong history of – quite reasonably – distrusting authority and/or business competitors was going to share financial information, accounting or purchasing details with a third party. Less sensitive things such as centralised sales, HR or marketing perhaps, but they were not going to flash their business knickers to strangers.
What this means for hotel owners/developers: They need to be diligent when negotiating HMAs that potential post-merger costs are addressed in the contract so that owners of hotels whose operating brands are acquired are not saddled with consequent merger costs or other contractual overrides imposed by the surviving operator company. Moreover, operators’ continuing consolidation efforts mean that owners need to ensure they retain some level of control, oversight and ownership of the essential back of house processes and systems to enable the hotel to function in the absence of the operator or its 3rd party subcontractors. And owners need to ensure that they or their asset managers have sufficient access to review and audit those essential processes performed outside the hotel’s walls.
As one can discern, operator consolidation has more implications for owners than just the “talking points” you hear.